Italian Prime Minister Silvio Berlusconi, the seemingly untouchable media magnate who has brushed off countless scandals and challenges to his rule, appears to have made his final stand. On Tuesday, he passed a crucial budget vote, but it was nothing more than a pyrrhic victory, as Berlusconi lost his Parliamentary majority and the support of his main allies, and will probably be forced to resign. The situation takes global proportions as the systemically dangerous $2.6 trillion Italian bond market is quickly reaching unsustainable levels with yields on benchmark 10-years surging past 6.7%.
“If I must die, I’ll do it in the House,” said a defiant Berlusconi on Tuesday. Hours later, he passed a key budget measure with 308 votes, seven short of a majority, as 321 lawmakers abstained. His loss of a governing majority sent Italian bond yields surging, and U.S. equity markets plunged deeper into negative territory. Major U.S. banks like JPMorgan and Morgan Stanley fell, while Goldman Sachs and Citi remained in the green.
The fear is that Italy’s massive debt, one of the world’s largest, will become unmanageable for a country that, despite a 3% budget surplus, still faces slow economic growth and a debt-to-GDP ratio of about 120%, according to Barclays. News reports cite the psychologically important 7% barrier as the point of no return for Italy’s bond yields, while Barclays notes they must fall to 5.5% in order to keep debt financing within reach of the Mediterranean nation’s finances.
Berlusconi appears to have played his last hand on Tuesday. Il Cavaliere, as the Prime Minister is nicknamed in Italy, was seen carrying a sheet of paper enumerating his options shortly before the vote, Italian daily Corriere Della Sera reported. “Do I take the confidence vote? Leave It? Technical Government? Reelection?” were listed on the paper, each with the pros and cons of each situation.
Vowing to meet his “traitors” in Parliament, Berlusconi's failure to marshal a 316-vote working majority on the budget measure suggested he would fail to pass a confidence vote, leading to calls for his resignation. Opposition leader Pierluigi Bersani of the PD party took the floor to ask Berlusconi directly to quit, while Umberto Bossi, Il Cavaliere’s ally and head of the Northern League, asked the Prime Minister to step aside and make way for Angelino Alfano, secretary of Berlusconi’s own PDL party.
For global markets, the problem is now whether Italy can fix itself and elicit much needed confidence, as the problem is not one of solvency but of trust. According to Barclays:
Greece was clearly insolvent, Portugal probably insolvent, and Ireland maybe insolvent, Italy is among the large group of sovereigns that, according to our calculations (and assuming a fiscal effort that is modest by international standards), are in a grey area: solvent if investors are highly confident in its fiscal sustainability, but insolvent if this confidence is weak
The problem for Italy now is that, once set in motion, these self-reinforcing negative dynamics are very difficult to break. At this point, Italy may be beyond the point of no return. Prompt and effective policy action from Rome may be necessary to remove Italy from the downward spiral that threatens it, but we doubt that it is sufficient.
With an EFSF that is too small to deal with an economy, and debt market, the size of Italy’s, the lack of a printing press, and clear international reluctance to bail the country out, the only solution seems to be a lender of last resort willing to step in. The ECB is “the only institution with the balance sheet available to play the required role,” according to Barclays, but the central bank, under both Mario Draghi and his predecessor Jean Claude Trichet, has been unwilling to take the task.
The situation remains fluid and it remains to be seen whether Berlusconi will indeed resign, and whether Italy can continue to access international markets for financing.